FDIC Offers Additional Insurance and Debt Guarantees

The Federal Deposit Insurance Corporation (FDIC) announced on Tuesday that it was instituting a new program, the Temporary Liquidity Guarantee Program, as yet another government attempt to strengthen confidence in the nation's banks and, hopefully to loosen credit mechanisms.

The plan will guarantee new senior unsecured debt of banks, thrifts, and certain bank holding companies and will extend full FDIC insurance to non-deposit bearing bank accounts regardless of the amount in the account.

The program will fully protect certain senior unsecured debt issued by participating financial institutions on or before June 30 of next year in the event the issuing institution or its holding company subsequently fails or files for bankruptcy.  The guarantee covers promissory notes, commercial paper, inter-bank funding, and any unsecured portion of secured debt.  The guarantee would be good through June 30, 2012 even if the debt maturity is after that date.

In a press release FDIC Chairman Sheila C. Bair said, "The FDIC is taking this unprecedented action because we have faith in our economy, our country, and our banking system.  The overwhelming majority of banks are strong, safe, and sound. A lack of confidence is driving the current turmoil, and it is this lack of confidence that these guarantees are designed to address."

The change in deposit insurance is meant to protect accounts, such as business payroll accounts, which almost by definition must exceed, if only for short and occasional period, the current $250,000 insurance limit.  This expansion of the insurance program is temporary and will expire at the end of 2009

According to Bair, the Temporary Liquidation Guarantee program will be funded through special fees and not taxpayer funds.

All FDIC-insured institutions will be covered under the program for the first 30 days without cost to the bank or holding company.  After that initial period, however, institutions wishing to no longer participate must opt out or be assessed for future participation. If an institution opts out, the guarantees are good only for the first 30 days.

Ms. Bair said that "Despite what we hear about the credit crisis and the problems facing banks, the fact is that the bulk of the U.S. banking industry is healthy and remains well-capitalized. What we do have, however, is a liquidity problem, largely caused by uncertainty about the value of mortgage assets, which is making banks reluctant to lend to each other, or lend to consumers and businesses.

"Today's actions to inject more capital into the banking system, combined with other recent coordinated measures to free up credit markets, should give banks the self-assurance to resume normal lending."

In other FDIC developments, The Wall Street Journal is reporting that Chairman Bair has criticized the $700 billion rescue package as not doing enough to prevent the wave of foreclosures currently sweeping the country.  Bair considers that this epidemic is at the root of the current economic problems.

In an interview with the Journal she said, she did not understand "Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level."

As an example, she pointed to the efforts made by Congress as they created the Hope for Homeowners program to ensure that homeowners participating in the program would not unduly profit when they later sold their homes.

"I support all the measures; I've been a part of all the measures that have been taken," she said. "But we're attacking it at the institution level as opposed to the borrower level, and it's the borrowers defaulting. That is what's causing the distress at the institution level. So why not tackle the borrower problem?"

According to the WSJ, the Temporary Liquidation Guarantee program described above was a compromise between Chairman Bair and other officials such as Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Beranke.  The two had tried to convince Bair to offer guarantees that covered a wider range of institutions and debt.